Earnings for the companies in the Standard & Poor’s 500-stock index are projected to increase just 5.4% in 2012 but to jump 13.4% next year. That seems like good news, but there is little evidence to suggest such a gain is achievable.

This quarter’s outlook doesn’t bode well: S&P 500 earnings are expected to decline on a year-over-year basis for the first time since 2009. Profit margins look high, suggesting little room for easy earnings gains through cost cuts.

S&P 500 companies turned 9.4 cents of each sales dollar into operating profit last quarter. The average since 1988 is 7.2 cents, and the record, 9.6 cents, came in 2006, near the peak of the housing bubble, says Howard Silverblatt, senior index analyst at S&P.

“You’re telling me we have double-digit earnings growth ahead of us?” says Silverblatt. “I’m skeptical.” He expects earnings estimates to fall between Thanksgiving and Christmas, when analysts typically re-examine their forecasts for the following year.

Of course, even if earnings disappoint, ultralow bond yields could give investors reason to favor stocks for their dividends. But history suggests interest-rate extremes tend to coincide with weak stock valuations, not strong ones.

Over the past eight decades, when 10-year Treasury yields were below the rate of inflation, as they were recently, the S&P 500
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has tended to trade below 12 times forward earnings estimates, according to a recent Morgan Stanley report. It is 13.7 times forward estimates now.

The good news for investors: Plenty of healthy U.S. companies have shares that trade at modest prices relative to their earnings. Investors generally expect these companies to produce only limited earnings growth in coming quarters. Those low expectations could help the shares outperform if earnings growth broadly disappoints in coming quarters, says Adam Peck, manager of the $2.8 billion Heartland Value Plus Fund
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Reuters

Caterpillar logo in the rental equipment yard of Holt Caterpillar, the largest Caterpillar dealer in the United States, in San Antonio, Texas.

Caterpillar’s low price reflects concerns that its earnings are vulnerable to an economic slowdown. But those concerns may work to the benefit of bargain hunters. Recent research by J.P. Morgan Asset Management suggests economically sensitive stocks are unusually cheap now.

The energy sector of the S&P 500, which includes Chevron, recently traded at 12 times 2012 earnings, the lowest ratio among 11 sectors. “Some of the energy-stock charts may turn your stomach now, but that’s what cheap stocks look like,” says Randall Warren, who manages $80 million at Warren Financial Service in Exton, Pa.

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